Debt to Income Ratio and Delayed Mortgage Payment - in a Repealing Relationship

We all know by now that Canadians are in debt trap. Well, when you look into the mortgage arrear rate (up to November, 2011) published by CBA then you would think twice. Mortgages in arrear rate is actually going down.

The prime rate has been going flat for some time but the arrear rates are still falling. It is possible that there is some lag in the two but this demonstrate that there is no clear relationship between Debt to income ratio and mortgage arrears.

The good news is that TD Chief Economist said in a report today;

The national housing market appears somewhat pricey, but is far removed from bubble territory.

Mortgage, debt and interest rates - where to?

House prices appear to be settling down a little bit recently. That is what we can figure out from the recent media publications. Industry studies and statistics from various sectors are pointing to a calmer housing market in future.

Small change in house price creates a butterfly effect in media at present. This shows the elevated fear factor we have about our own home prices.

The house price bubble anxiety has a solid core cause. Our income has been deteriorating over past years. The numbers show a small increase in our annual wages over the years but compared to inflation rate it is not enough to fill the gap.

When income fails to keep up with expense we start to look for alternative means. A second job or working few extra hours usually are the primary means of meeting the ends. When jobs are scares then borrowing is an alternative to all those, especially when the interest rates are low.

Borrowers flocked to re-finance their homes to get few extra bucks. When the government found that out - they withdrew the backstops from the refinances last year.

As always, government has a very difficult task ahead of them. Financial problems are a big headache for the ruling party. Regardless if the ruling political party had anything to do with a financial problem in the country or not they face the heat from the public. The election results in 1980 and 1993 in Canada may have some stories to tell if we look at the prime rate chart.

With the weak job market, low demand and anaemic European economy – the government would find it difficult to take harsh action. It would probably take small step at a time.

These all implies that we are in a statuesque Status-Quo. Shouldn’t we worry about that? Not to worry, it is not going to last long. If anything is constant in our society that is change. These fine balances of forces are maintained by various quivering factors. When one fails then a re-distribution of forces occurs which will write the history in a different way – trying to guess that is futile.

Looking at the present we can see that there are many worrying factors waiting to become a serious problem.

Canadian households are now at a debt-to-income ratio of 151 per cent. Unfortunately paying down debt was in our New-Years resolution list but it appears that we have broken it already.

Boomers are gathering debt faster than before. The problem with middle age workers collecting debt load is nothing new. The alarming part of the trend is that they are doing it at a faster pace now.

Our real income is failing to keep up with inflation.

One interesting thing to note - last month TransUnion reported that average consumer’s total debt (excluding mortgage) dropped in third quarter. A report by the Vancouver Sun at the same time mentioned that Ratio of annual disposable income vs debt reached 152% in Q3 - 2011, up from 150.57% in the Q2 of the year. The latest CIBC report says the ratio is 151%. The numbers are different from each other because they all use different sample and benchmarking.

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May be we are in a housing bubble right now. There are possibilities of a house price correction in future. But the bottom line is that the banks are publicly listed companies – if we are heavy with debt then they are no exception to that. There is one more thing to add - RRSP season is approaching and they need to collect funds.

Last June CIBC reported that Canadian debt problem is stabilizing. It has reported otherwise this time. This time (source) it may very well be the holiday effect.

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Sources:

Statcan: 1, 2,3,4,5, 6

Payroll Assoc: 1, 2

Vanier Institute:

CGA:

Bank of Canada: 1, 2,3

CIBC: 1, 2,3

Weekly Dose of Vitamin-M

As it came out of the blue - it departed behind the stage - yes, BMO’s 2.99% 5 years fixed rate had gone (for now).

Two of big six banks have brought five years fixed posted rate down to 5.14 percent, others should move by next week.

BMO, after flirting with the fixed rate, it is now courting Canadian businesses with $10bn.

Mortgage News:

Inflation takes a breather in Canada - Globe and Mail

Canada Had Fastest Inflation in 2011 Since Central Bank Began Targeting - Bloomberg

Time ripe for mortgage move - Windsor Star

My $3,900 mortgage penalty: How do they figure? - Toronto Star

More mortgage rules planned if housing market gets too hot - National Post

US rate hikes unlikely until late 2014 - CBC

Canadian borrowing surge driven by most indebted households: CIBC

10-year mortgage is worth a look - Toronto Star

RRSPs or TFSAs: Which is better to use when buying your first home? - Financial Post

Connect the housing bubble dots: There could be trouble on CMHC’s horizon - Globe and Mail

Real-estate News:

Canadian home prices slide for first time in a year - Financial Post

Realtysellers gets green light for lawsuit - Globe and Mail

Toronto real estate safe as houses - Toronto Sun

For Chinese buyers, ‘hongza’ rings death knell for property prices - Toronto Star

Canadian home prices dip for first time since fall, 2010 - Globe and Mail

The new-home market is shifting into high gear - Toronto Star

Dr. Doom reveals what lies ahead and where he’s stashing his money - Globe and Mail

Real estate may do an encore - Financial Post

Is your neighbourhood hot or not? - Toronto Star

Before Buying a House, Do the Math - Huffington Post

Canadian home prices dip for first time since fall, 2010 - Globe and Mail

Canadian real estate market: Some regions could slow or even contract - Desjardins

Pending housing bubble spells trouble for Canada, experts say -Financial Post

As Toronto condos shrink, space grows precious - Globe and Mail

Real estate: Investing in the U.S. - Globe and Mail

What happens when Canada's housing bubble pops? - Macleans

Why it’s a good time to buy a home - Toronto Star

Financial News:

Canadian Currency Touches Parity for First Time Since November - BusinessWeek

Do you really know how much your debt costs you? - Globe and Mail

Really, an increase in household debt isn’t all bad - Globe and Mail

Majority of Canadians feel financially unprepared for retirement - ING DIRECT

Canadian pensions post lacklustre gains in turbulent year - RBC Dexia survey

Don?t pay interest on money you don?t owe - Globe and Mail

Stalled on the road to economic recovery - Globe and Mail

How many credit cards is too many? - Globe and Mail

Borrowing Boomers pile on more debt - Toronto Star

Job quality worsened in 2011, CIBC report says - CTV

Other News:

Real-estate board warns of appliance thefts - CBC

Online mortgages boom despite housing bust - Reuters

Analysis: Banks expect to spend less on bad mortgages - Reuters

Key dates in Greece's debt crisis - Associated Press

Thanks for reading. Have a good weekend.

US rates to stay low till 2014

Canadian interest rates are not directly related to what happens in United States - but as our largest trading partner it is good to know what is going on there.

Today Reuters reported that US Federal Reserve Chairman Ben Bernanke said the central bank is considering additional stimulus to keep the interest rates low till late 2014.

According to a report by CBC, the fed chairman said "Strains in global financial markets continue to pose significant downside risk to that outlook". This statement is in line with what Mark Carney, Governor of the Bank of Canada, said a few days ago; "The outlook for the global economy has deteriorated and uncertainty has increased since the Bank released its October MPR".

National Bank housing price shows a drop in house price in November 2011. It will be interesting to see the effect of this drop along with the low interest rates in the late and early spring this year.

Refinancing at a lower rate - Do you think you can save?

In a low rate environment if you have one of those Dinosaur fixed rates from mid to end 2008 then you are probably blaming everyone but yourself for the loss. Those days, back in 2008, there was a time when 5 years fixed rate mortgages were about 5%. It was just the beginning of the bad time. House prices were low, economy was slow - Do not blame yourself - you took the right decision by going for a fix rate mortgage.

Unfortunately the rates did not go up as it was anticipated at that time. It has been three years since then you ate that bitter pill which is still stuck in your throat (wallet).

After seeing all your buddies flocking to lower rates - you have finally decided to give that broker friend of yours a call and find out what is the rate. At the same time your existing lender have received the ultimatum from you.

All set and planned - waiting for the final execution. Before you press that button - ask yourself once again if you would have saved anything and by how much? That question may save you from being sorry again.

Say, you have a $100,000.00 mortgage on your property. You are paying 5% interest on a five years fixed term, and have 2 years left on it. Now say, you get 3% for fixed rate and want to save some money by breaking your existing mortgage contract and get into a new one with lower rate. Let us also assume that the bank can re-invest that $100,000 at an interest rate of 3.0% (Very Optimistic Rate). Now we should find out how much you shall save.

Current Mortgage: If we continue with the present mortgage then in the next two years the total (24 months) interest amount on that would be - $9,434.98. Let us not talk about the principle payment when we are looking at the expenses.

New mortgage: If we go for a new interest rate then our total interest payment for first two years on a 3% five years fixed mortgage would be - $5,842.61. Again, principle payment is not a matter of concern as we should look at the expenses.

Penalty and charges:

First to calculate Interest Rate Differential - You can easily feed this formula in excel IRD = IPMT[(5.0-3.0)/12,1,24,100000] X (-24) = $4,000.00..

Now there are other charges.

Lenders Re-investing fee - $50.00 to $1000.00

Lenders admin fee - $100.00

Title Insurance with another lender - $250.00

Lawyer fees - $500.00

We now end up with total expense of;
4000 + 200 + 100 + 250 + 500 = $5050
Our savings in interest - $9,434.98 - $5,842.61 = $3592.37
Net Loss = $1457.63 ($5050 - $3592)

Again, this is considering that your lender would actually agree to a 3% re-investment rate. If it is lower, then the loss is even more.

So, when do you save money on this deal? Here are few conditions.

Some would say that with a lower monthly payment you would pay more into principle. Let's have look into that now.
With the old loan you would have paid about $2,600.00 towards principle - in the last two years of five years term - while paying $501.43 every month on 35 years amortization.
With the new interest rate you would pay $4,252 towards your principle in first two years while paying $420.61 every month on 30 years amortized mortgage.
(Note: 35 years is no more available except some lenders).
Technically you pay $1652 extra in your principle while paying less per month. That takes your $1457.63 loss back to black ink.
You save about $200 after all said and done.

The penalty could be lower depending on market condition and lender.

Depending on your situation you may save on lawyer fees.

The interest payment is less too but that is already taken into account while we calculated the total interest charge difference.

On a larger loan amount you save more.

If you refinance to include the penalty amount then you barely save anything.

In the end, do you research, evaluate your options and then decide. Do not take emotions into account and don't get fooled by apparent savings, look at the whole picture.

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Disclaimer: All the lenders have their own way to calculate IRD. The formula may be the same but the re-investment rates are different for each one. Some lenders will consider their advertised rate for that remaining term and some will take BOC bond yield plus some constant rate. They vary widely. You better talk to your lender to find out.

Rates and other numbers used in this post are made-up for calculation purpose only.

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